INSIGHT: How Revenue Has Changed for Public Energy Companies

Public entities have just wrapped up first quarter filings reflecting the new revenue recognition standard, Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). These recent U.S. Securities and Exchange Commission filings give us insight into the most significant changes for the energy sector. After costly and time-consuming implementation efforts, most filers didn’t see a material change to the bottom line or the timing or pattern of revenue recognition for major income streams. The effect on net income belies the efforts to date, including reviewing contracts, redrafting accounting policies, updating internal controls, and modifying IT systems.

This is the first major principles-based standard that will require substantially more management judgment, supporting documentation and disclosure than previous strict criteria-based guidance. In some cases, companies may reach different conclusions on seemingly similar transactions, based on a company’s specific facts and circumstances. SEC comment letters on early adopters have focused on determination of single versus multiple performance obligations, especially management’s judgments, licensing arrangements, level of disaggregation and inconsistencies in the totality of company disseminated information.

This article focuses on those items in the new model that will have the greatest effect on energy companies and includes all subsequent amendments, Transition Resource Group (TRG) clarifications, finalized and exposed guidance from the American Institute of CPAs revenue recognition oil and gas (O&G) task force, and SEC views gathered from official speeches. The SEC previously announced it expects registrants to reflect TRG decisions as they implement the new guidance—any differences in accounting would need to be discussed with SEC staff.

01

Scope

The new revenue standard applies to all contracts with customers, except for those within the scope of other standards. If the other accounting guidance specifies how to separate and/or initially measure one or more parts of a contract, an entity first should apply those requirements before applying Accounting Standards Codification (ASC) 606. The scope determination not only ensures the correct accounting guidance is applied, but also determines income statement presentation—any income streams not in ASC 606’s scope must be broken out separately in the financial statements.

Commodity Exchange Arrangements

In CEAs, an entity agrees to sell a certain quantity and grade of a commodity to a counterparty at a specified location and simultaneously agrees to buy a specific quantity and grade of a similar commodity from that same counterparty at another location—the party’s specified inventories are exchanged, e.g., in-ground natural gas liquids are exchanged at different storage hubs. Although a CEA counterparty may meet the ASC 606 customer definition, nonmonetary exchanges between two parties in the same line of business are outside the new standard’s scope and would be accounted for in accordance with ASC 845, Nonmonetary Transactions. This conclusion also would apply to a marketer that sells crude oil or gas to a refiner or gas processor and simultaneously buys back separate, refined products such as condensates or natural gas liquids. For nonmonetary exchange contracts with customers not in the same line of business, ASC 606 would apply.

Production Imbalances—Balancing Arrangements

A producer imbalance arises when an owner of one or more working interests sells a volume of production higher (over lift) or lower (under lift) than its entitled share of production for a period. The over lift party has an obligation to settle the imbalance with the under lift party financially or in kind by the end of the property’s life. SEC guidance in ASC 932-10-S99-5 previously permitted owners to record revenue related to these arrangements by using either an entitlements method or sales method. Under the entitlements method, an owner generally records revenue equivalent to its share of production and a payable (over lift) or receivable (under lift) for the difference between volumes it actually sold to third parties and its working interest. Under the sales method, an owner generally records revenue for the actual amount of the production sold to third parties and adjusts reserves for any shortfall. A follow-up set of amendments to ASC 606 in ASU 2016-11 eliminated this SEC guidance. Therefore, if the sales contract with the third party is considered a customer contract, revenue on those sales would be recognized in accordance with ASC 606.

Joint Operating Agreement

In general, a transaction with another working interest owner will be accounted for under ASC 606 if the counterparty is considered a customer in the specific transaction. Companies should consider whether other applicable guidance—ASC 808, Collaborative Arrangements—should be applied when an arrangement is not with a customer. The property operator may be reimbursed by the other working interest owners for overhead costs incurred. The JOA governs how reimbursement amounts are calculated and allocated. Because these payments represent the shared risks and rewards for their joint, undivided ownership interest in the property, these arrangements do not represent a vendor-customer relationship and the other working interest owners do not meet the definition of a customer. The oil and gas task force concluded these reimbursements generally are not considered revenue from contracts with customers subject to ASC 606. However, entities that serve as contract operators and are paid to operate properties in which they do not have a working interest would be subject to ASC 606 and should record the reimbursement as revenue in the income statement. In other cases, operators may provide services for other joint operating interest holders and for other third parties in the same field. If these services are outputs of the entities’ ordinary activities, they should be evaluated to determine if there are performance obligations for such services that are part of a contract with a customer subject to ASC 606.

In May, the Financial Accounting Standards Board issued an exposure draft with proposed changes to ASC 808 guidance to reduce current diversity in practice by clarifying the interaction between ASC 808 and ASC 606 and refining presentation requirements.

Derivatives Versus Normal Purchases & Normal Sales

Contracts for the purchase or sale of oil and natural gas often meet the definition of a derivative and would continue to be subject to the guidance in ASC 815, Derivatives and Hedging, including the related disclosure requirements rather than the more voluminous ASC 606 disclosure requirements. Contracts expected to result in physical delivery may be eligible for the normal purchases and normal sales (NPNS) scope exception in ASC 815. NPNS are contracts for the purchase or sale of a nonfinancial asset or derivative instrument that will be deliverable in quantities expected to be used or sold by the reporting entity over a reasonable period in the normal course of business. The NPNS exception is a contract-by-contract irrevocable election, which allows qualifying contracts to be accounted for as a normal sales contract rather than a derivative. If an entity elects to treat a physical commodity sale contract as a normal sale, that sale contract typically should be accounted for as a contract with a customer following the guidance in ASC 606.

Sales of Mineral Interests

Industry guidance in ASC 932-360, Extractive Activities—Oil and Gas—Property, Plant, and Equipment, remains in effect for conveyances of mineral interests and oil and gas properties and, therefore, outside ASC 606’s scope. An entity’s sale and retention of its operating and nonoperating interests in a well would continue to be accounted for under ASC 932. However, that same entity’s sale of its drilling equipment on the property would be accounted for in accordance with ASC 606 because guidance in ASC 360-20, Property, Plant, and Equipment—Real Estate Sales, has been superseded and replaced by ASC 610-20, which governs the accounting treatment for partial sales of nonfinancial assets.

Production Payments

Production payments are covered by guidance in ASC 932 and, therefore, out of ASC 606’s scope. A volumetric production payment that is repaid in a specified amount of commodity lifted from a specific mineral interest and delivered free and clear of all expense associated with that interest’s operation reflects a sale of that mineral interest and also is outside ASC 606’s scope.

Contributions in Aid of Construction

Contributions in aid of construction (CIAC) represents money or other property contributed to a regulated utility to ensure the appropriate parties are paying for utility infrastructure costs and the service price is economical and fair for all customers. The accounting for CIAC is subject to interpretation and will require management judgment, supporting documentation and disclosure if amounts are material. The power and utilities task force concluded CIAC can reasonably be viewed as a cost reimbursement from a customer that is not within ASC 606’s scope. The task force noted this analysis requires the exercise of judgment and that others may reach different conclusions based on the facts and circumstances of their arrangements.

Alternate Revenue Programs

Guidance in ASC 980, Regulated Operations, was amended to specifically exclude alternate revenue programs (ARPs) from ASC 606 because such programs represent contracts between the utility and its regulators, not customers.

02

Step 1: Identify the Contract with a Customer

For energy companies, the biggest challenge in this step will be evaluating the accounting for contract changes. Previous revenue guidance did not include an accounting framework for contract modifications, except for construction and production-type contracts. Accounting for contract modifications will depend on the type of modification. A contract modification would be recognized as a separate contract only if distinct goods or services are added for additional consideration that reflects their standalone selling prices.

If these two criteria are not met, the modification would be accounted for on a combined basis with the original contract, either prospectively or on a cumulative catch-up basis, depending on whether the remaining goods or services are distinct from the goods or services transferred before the modification. If distinct, the modification is accounted for prospectively with the unrecognized consideration allocated to the remaining performance obligations and revenue recognized when (or as) the remaining performance obligations are satisfied.

If the remaining goods or services are not distinct, the modification is accounted for as if it were part of the existing contract, forming part of a single, partially satisfied performance obligation at the date of the modification. The modification’s effect on the transaction price and on progress toward satisfaction of the performance obligation is recognized as an adjustment to revenue on a cumulative catch-up basis.

Blend & Extend Contract Modifications

In a typical blend and extend (B&E) modification, the supplier and customer may renegotiate the contract to allow the customer to take advantage of lower commodity pricing while the supplier increases future delivery. The customer and supplier agree to “blend” the remaining original higher contract rate with the lower extension-period rate for the remainder of the original contract term plus an extended term. Depending on the specific facts and circumstances, two accounting approaches could be a reasonable interpretation of ASC 606:

§ The extension period is a separate contract, and the modification results in the addition of distinct goods or services because the additional deliveries are discrete and separate from the deliveries under the original contract. A seller could conclude the price of the contract increases by an amount of consideration that reflects the entity’s standalone selling price for the additional deliveries. As such, the seller would continue to recognize revenue at the premodification contract rate during the remainder of the original term and would record the difference between the new contract rate and original rate as a contract asset. The contract asset would unwind during the extension period as the recorded revenue would exceed the billed amounts.

§ The modification is a termination of the existing contract and the creation of a new contract because the additional deliveries are distinct, but the remaining consideration for the goods yet to be provided (the blended price) is not consistent with the then-current standalone selling price of those remaining deliveries. The new contract would be accounted for as a single performance obligation satisfied over time (a series of distinct goods or services), and revenue would be recognized at the contract rate.

Companies should establish an approach based on the facts and circumstances of their modifications and apply that approach consistently to similar fact patterns. Companies should disclose their approach, if material.

03

Step 2: Identify Performance Obligations in a Customer Contract

Under ASC 606, performance obligations and fulfillment of them determine revenue recognition. Properly identifying the performance obligations will be time-consuming but critical because these determinations drive the pattern of revenue recognition and financial statement disclosures. A performance obligation is a promise to transfer goods or services to a customer that can be explicitly identified in a contract or implied by customary business practices, published policies, or specific statements.

Material Right

A contract may contain an option to acquire additional goods or services. A separate performance obligation could exist if the option provides a material right to the customer that it would not receive without entering into that contract. Material right obligations must be separately valued to allocate part of the transaction price to those specific performance obligations. This topic generated a number of discussions at TRG meetings. Management judgment will be required in making this determination. The identification of a material right affects the pattern of revenue recognition in Step 5.

Volume Variability/Volumetric Optionality

Arrangements that include volume variability, such as take-or-pay arrangements, should be evaluated to determine if the optional purchase creates a material right. Options for customers to purchase additional goods or services would not be considered performance obligations. Therefore, the resulting consideration would not be included in the transaction price unless the options give rise to a material right, such as, additional quantities at prices that are significantly in-the-money at contract inception. If the optional purchases do not give rise to a material right, an entity would only account for the optional purchases when exercised.

Stand-Ready Obligations

ASU 2014-09 notes that a contract may include “a service of standing ready to provide goods or services or of making goods or services available for a customer to use as and when the customer decides.” TRG members generally agreed the promise in a stand-ready obligation is the assurance the customer will have access to the good or service, not the delivery of the underlying good or service. This conclusion determines the pattern of revenue recognition in Step 5.

Series Provision

The series provision is a concept introduced in ASU 2014-09 and does not exist in current generally accepted accounting principles (GAAP). The series provision requires goods or services to be accounted for as a single performance obligation in certain instances, even though the underlying goods or services are distinct. A series of distinct goods or services should be accounted for as a single performance obligation if they are substantially the same, have the same pattern of transfer and meet both of the following criteria:

§ Each distinct good or service in the series represents a performance obligation that will be satisfied over time.

§ The entity would measure its progress toward satisfaction of the performance obligation using the same measure of progress for each distinct good or service in the series.

Entities will need to determine whether a single performance obligation is created in this manner to appropriately allocate variable consideration and apply the guidance on contract modification and changes in transaction price (see Step 3). This provision prevents an entity from having to allocate the transaction price on a relative standalone selling price basis to each increment of a distinct service in repetitive service contracts.

TRG members agreed a series of distinct goods or services need not be consecutively transferred. The series guidance also must be applied even when there is a gap or overlap in an entity’s transfer of goods or services if the other criteria are met. The TRG also addressed questions related to the application of the series provision to service contracts. If the nature of the promise is the delivery of a specified quantity of a service, then the evaluation should consider whether each service is distinct and substantially the same. If the nature of the entity’s promise is the act of standing ready or providing a single service for a period of time, the evaluation likely would focus on whether each time increment—rather than the underlying activities—is distinct and substantially the same.

Step 3: Determine the Transaction Price

Revenues are recorded at the transaction price, which is the amount the entity expects to be entitled to and which may be net of amounts paid on behalf of others (including royalties), discounts, and allowances, as applicable. Contracts for the forward sale of commodities often are priced by reference to forward commodity price curves that often are available for the key components of energy contracts (power, gas, capacity, etc.). Although the forward commodity curves may be a component of the contract price, there are a number of other pricing components that should be considered when determining the amount of consideration the seller expects to receive—counterparty credit, delivery location, and other entity-specific factors that may materially affect the price.

Upfront Payments

A contract that includes options for additional goods or services may include an upfront payment—an amount that may reflect the present value of the difference between a fixed price for optional quantities and consideration determined by using the supplier’s forward commodity price curve. The upfront payment should be included in the transaction price, which would be allocated by applying the ASU’s allocation method to the performance obligations identified (which may include a separate performance obligation for a material right). (See Step 4).

Several factors go into determining the transaction price, which are noted below.

04

Step 4: Allocate the Transaction Price to Performance Obligations

An entity would allocate the transaction price to performance obligations based on the relative standalone selling price of separate performance obligations. The best evidence of standalone selling price would be the observable price for which the entity sells goods or services separately. In the absence of separately observable sales, the standalone selling price would be estimated by using observable inputs and considering all information reasonably available to the entity.

Several approaches could be used—adjusted market assessment, cost plus margin or residual value. The new standard does not specify how to determine the standalone selling price, such as use a calculated value, current market price or forward price, for contracts that entities determine have separate performance obligations for each unit of the commodity. ASC 606 does not require entities to use forward curves as the standalone selling price simply because there are observable commodity price curves. In the absence of a significant financing element or other factors into the determination of the contractual selling price, it may be reasonable to use the invoice price as the standalone selling price when allocating the transaction price to the performance obligations associated with delivery of storable commodities.

Variable Pricing & Constraint

The new revenue model requires variable consideration be included in the transaction price if it is probable that subsequent changes in the estimate would not result in a significant reversal of revenue. This concept is commonly referred to as the “constraint.” The ASU requires entities to perform a qualitative assessment that takes into account the likelihood and magnitude of a potential revenue reversal and provides factors that could indicate an estimate of variable consideration is subject to significant reversal such as susceptibility to factors outside the entity’s influence, long period before uncertainty is resolved, limited experience with similar types of contracts, practices of providing concessions, or a broad range of possible consideration amounts. This estimate would be updated in each reporting period to reflect changes in facts and circumstances. When the transaction price includes a variable amount, an entity must estimate the variable consideration by using either an “expected value” (probability-weighted) approach or “most likely amount” approach, whichever is more predictive of the amount to which the entity expects to be entitled.

Take-or-Pay Arrangements

For the undelivered goods in a take-or-pay arrangement, oil and gas companies only may recognize revenue when the likelihood of reversal is remote.

Significant Financing

Contract terms may explicitly or implicitly provide the entity or the customer with favorable financing terms. An entity is required to adjust the transaction price to reflect the time value of money if the financing component is significant—the transaction price should reflect a selling price as though the customer had paid cash at the time of transfer. Payment terms in the energy industry often include upfront fees or extended payment terms, e.g., long-term volumetric production payments. Under current guidance, arrangements that offer extended payment terms often result in the deferral of revenue recognition, because the fees are typically not considered fixed or determinable unless the entity has a history of collecting fees under such payment terms without providing any concessions. In the absence of such a history, revenue is recognized when payments become due or when cash is received from the customer, whichever is earlier. Typically, under today’s accounting, there would be no adjustment for advance payments.

Under ASC 606, if the financing term extends beyond one year and a significant financing component is identified, the entity would need to initially estimate the transaction price by incorporating the effect of any variable pricing and then adjust this amount to account for the time value of money. When the entity is providing financing, interest income would be recognized as the discount on the receivable unwinds over the payment period. However, when the entity receives an upfront fee, the entity is deemed to be receiving financing from the customer and interest expense is recognized, with a corresponding increase to revenue recognized. This recognition pattern may differ from the pattern under current U.S. GAAP.

B&E Contract Modification

There is no presumption that a B&E contract modification contain an inherent financing element—the mere act of blending the rate in connection with a contract extension does not create a financing, that would require separate accounting. Each contract’s facts and circumstances would have to be evaluated.

Variable Volumes—Requirement Contracts

Energy companies often use requirement contracts to buy and sell electricity or gas. These contracts provide for delivery of as much electricity or gas as the customer needs. Customers use these variable-quantity contracts to source supply to meet their expected need. The pricing for such contracts generally is known at the time the contract is executed and reflects the standalone selling price. Although such contracts may take different forms, including a single price for all deliveries or different but specified prices depending on the time of day and/or season of year, the primary unknown at the time of contract execution is the ultimate quantity to be delivered.

Accounting for a contract that contains an option to purchase additional goods and services and a contract that includes variable consideration sometimes would result in minimal differences in the timing and measurement of revenue recognized in a reporting period. For example, the accounting for a contract that requires an entity to process transactions for a constant amount of consideration per transaction over a specified period likely would result in revenue recognized as each transaction is processed. This would be the case regardless of whether each transaction processed was considered an optional purchase or, instead, variable consideration for the entity’s service of processing transactions over the specified period. However, there could be a difference in required disclosures. If each transaction was considered an optional purchase, an entity would not be required to disclose an estimate of the consideration received from the exercise of future options. In contrast, if each transaction processed was considered variable consideration, the entity would be required to estimate the remaining transactions to be processed to disclose the transaction price allocated to the remaining performance obligations unless it qualifies for one of the practical expedients.

Management judgment will be needed to distinguish between contracts with an option to purchase additional goods or services and contracts that have variable consideration. The TRG concluded the determination of whether a contract has variable consideration or an optional purchase is highly dependent on the evaluation of the nature of the promise in the contract and provided some distinctions:

§ Options for additional goods or services: The customer has a present contractual right that allows it to choose the amount of additional distinct goods or services purchased. Prior to the customer’s exercise of that right, the vendor is not obligated to provide—and does not have a right to consideration for delivering—those goods or services.

§ Variable consideration: The customer previously has entered into a contract that obligates the vendor to transfer the promised goods or services. The future events (including the customer’s own actions) that result in additional consideration occur after (or as) control of the goods or services have (or are) transferred. The customer’s actions do not obligate the vendor to provide additional distinct goods or services (or change the goods or services to be transferred).

An entity may have to estimate the volumes transferred for the timely preparation of financial statements. For the sale of gas production, the oil and gas task force believes that if the actual volumes transferred are not known in time to prepare financial statements, entities should record revenue based on an estimate of the volumes delivered at the agreed-upon price and then adjust revenue in subsequent periods based on data received from the purchaser that reflects actual volumes received. This recognition would be subject to the revenue constraint. In general, proceeds from gas production are received from one to three months after the actual delivery has occurred, and gas revenue is estimated based on prior months’ production volumes and current lease operating data, such as meter readings. Revenue associated with liquefied natural gas, liquefied petroleum gas, gas-to-liquids and products from other emerging technologies should be analyzed to ensure appropriate recognition policies are in place.

Noncash Consideration

If a customer promises consideration in a form other than cash, an entity would measure the noncash consideration at fair value to determine the transaction price. If a reasonable estimate of fair value of the noncash consideration cannot be made, the entity would use the estimated selling price of the promised goods or services, similar to current accounting standards. A subsequent amendment to ASU 2014-09 clarifies noncash consideration would be measured at contract inception. Subsequent changes in the fair value of the noncash consideration due to the form of the consideration would be recorded, if required, as a gain or loss in accordance with other accounting guidance—rather than as revenue.

Step 5: Recognize Revenue

An entity would recognize revenue when (or as) the entity satisfied a performance obligation by transferring a promised good or service to a customer. If the performance obligations are satisfied at a point in time, the associated revenue would be recognized at that point in time. How does this principle apply to a commodity? When a commodity is not treated as a derivative, is the nature of an energy company’s promise to deliver a commodity at a point in time or to provide a service of delivering a commodity the customer consumes and from which the customer benefits over time? This determination affects the timing of revenue recognition, a company’s ability to apply the series guidance (Step 2), and the disclosure requirements. Distinct goods or services that are substantially the same and transfer over time are a series, which may allow companies to recognize the amounts billed as revenue. Distinct goods or services that transfer at a point in time are not eligible for the series guidance, meaning an entity would be required to estimate prices and quantities when determining transaction price and allocate the transaction price to the performance obligations based on the projected delivery quantities.

The TRG concluded an entity should consider all relevant facts and circumstances in assessing the pattern of revenue recognition. An entity may consider not only the inherent nature of the commodity, but also specific contract terms, like a continuous supply contract to meet immediate demands, and information about infrastructure or other delivery mechanisms, for example, a natural gas utility delivering directly to residential consumers. The performance obligation for the sale of oil and gas production not simultaneously received and consumed,— like crude oil)— generally is satisfied at a point in time (transfer of the goods to the customer). The performance obligation for the sale of oil and gas production simultaneously received and consumed—natural gas sold to and immediately consumed by a third-party power plant operator—would meet the criteria for over time recognition.

Presentation

Any income streams outside ASC 606’s scope must be separately identified on the income statement, including—but not limited to—collaborative arrangements, certain commodity exchange transactions, derivatives, leases, and alternative revenue programs. Entities will need to make this disclosure in the notes to the financial statements, if not presented separately on the face of the financial.

Presentation of Sales Taxes

Step 3 of the standard as originally issued required amounts collected on behalf of third parties to be excluded from the transaction price. Entities would have had to evaluate all taxes to determine if the tax is levied on the entity or the customer—this analysis would include sales, use, excise and value-added taxes. Assessment would have been on a tax-by-tax and jurisdiction-by-jurisdiction basis, a costly and operationally challenging process. FASB reconsidered, and a subsequent set of amendments allows entities to make an accounting policy election to present sales taxes collected from customers on a net basis.

The practical expedient would apply to all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction and collected by the entity from a customer. Taxes assessed on an entity’s total gross receipts or imposed during the inventory procurement process are excluded from the scope of this election. An entity not making this accounting policy election would apply the new revenue standard—as originally issued—in determining if those taxes should be included in the transaction price. Most of the large energy companies have indicated they will exclude sales-based taxes collected on behalf of third parties from the transaction price.

For SEC reporting companies, Rule 5-03 of Regulation S-X still requires that the amount of excise taxes be shown on the face of the income statement (parenthetically or otherwise) if such taxes are included in revenues and are equal to 1 percent or more of the total.

Disclosures

The objective of the disclosure requirements is to enable financial statement users to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Companies that have early-adopted the standard have found this area to be more challenging than initially anticipated, even with significant relief for nonpublic entities. In most cases, additional data will need to be collected and additional monitoring and record keeping will be required. Energy companies should ensure they have systems, internal controls, and procedures in place to accumulate the information required to satisfy these new presentation and disclosure requirements. Speeches by SEC officials emphasize the need for specific company judgments and not boilerplate language. Companies should consider the totality of information disseminated to avoid inconsistency in messaging between financial statement notes and other investor or marketing communications.

Existing disclosure guidance in ASC 410, 845 and 932 continues to apply.

06

Disaggregation

When determining how to disaggregate revenue for disclosures, an entity should consider how investors, regulators and lenders use the information to evaluate the entity’s financial performance. Public entities must disaggregate revenue in meaningful categories. This could be by type of commodity, geographical region or type of contract. Entities must disclose sufficient information to enable users to understand the relationship between the amounts from this disclosure and those reported for segment reporting purposes if they are different.

Performance Obligations

All entities must disclose how performance obligations are satisfied—at a point in time or over time, significant payment terms, if the consideration is variable and if the estimate of variable consideration is constrained. All entities must describe the nature of goods or services provided, highlighting if an entity is acting as an agent.

Transaction Price Allocated to the Remaining Performance Obligations

Companies may have remaining performance obligations at the end of the reporting period. The following disclosures are required for public entities:

§ The aggregate amount of the transaction price allocated to the performance obligations unsatisfied at the end of the reporting period

§ An explanation of when the entity expects to recognize such revenue in either of the following ways:

• Quantitatively using time bands based on the duration of the remaining performance obligations

• Qualitatively

FASB provided two practical expedients from the above requirement:

§ Disclosure is not required for remaining performance obligations if either of the following conditions is met:

• The contract has an original expected duration of one year or less

• The entity recognizes revenue in an amount that directly corresponds with the value of the performance completed to date, for example, an entity bills a fixed amount for each hour of service provided

§ Disclosure is not required for variable consideration within unsatisfied performance obligations if either condition is met:

• The variable consideration is a sales- or usage-based royalty promised in exchange for a license of intellectual property

• The variable consideration is fully allocated to a wholly unsatisfied performance obligation or wholly unsatisfied promise to transfer a distinct good or service that forms part of a single performance obligation under the series provision

If an entity elects either of these practical expedients, it must disclose what exemptions it is applying, the nature of the performance obligations, remaining duration, and a description of the excluded variable consideration. An entity shall explain whether any consideration is not included in the transaction price and, therefore, not included in the information disclosed, e.g., an estimate of the transaction price would not include any estimated amounts of constrained variable consideration.

Significant Judgments

All entities are required to disclose judgments and changes in judgments that significantly affect the amount and timing of revenue from customer contracts. This includes the timing of satisfaction of performance obligations and the transaction price and amounts allocated to performance obligations.

All entities also must disclose the methods, inputs and assumptions made in assessing whether an estimate of variable consideration is constrained. Only public entities additionally must disclose the methods, inputs, and assumptions for determining the transaction price, including estimating variable consideration, adjusting for significant financing, and measuring noncash consideration and allocating the transaction price to goods and services.

Capitalized Contract Costs

If a public entity capitalized costs to obtain or fulfill a contract, it will be required to make the following disclosures:

• Description of the judgments made in determining the amount of the costs incurred to obtain or fulfill a contract;
• Description of the method to determine the amortization for each reporting period;
• The closing balances of assets recognized from the costs incurred by main category of asset, e.g., costs to obtain contracts, precontract costs and setup cost; and
• The amount of amortization and any impairment losses recognized in the reporting period.

SEC Requirements

The SEC currently requires a public company that retrospectively adopts an accounting standard to provide five years of comparable data based on the new accounting policies. SEC staff will not object if companies that adopt on a full retrospective basis do not restate the earliest two years in their five-year selected financial data disclosures. A company only will be required to reflect the accounting change in the summary for the three years for which it presents full financial statements elsewhere in the filing. If elected, clear disclosure about the lack of comparability would be required.

Conclusion

The adoption of this ASU will be complex and likely will require significant hours to correctly implement. The effect on each energy company will vary depending on existing revenue streams and estimation methodologies. Even if the amount or timing of revenue recognition does not change, presentation and disclosure will. In addition, companies will have to redraft accounting policies under the new principles and update internal controls for the increases in management’s judgments.